Income Inequality

INCOME INEQUALITY IS THE uneven distribution of earnings among the population of a country, region, or entity resulting in an inequality of access to commodities. Income inequality may also stem from lack of access to some goods and services. For instance, lack of opportunity to receive education and training leads to lower earnings for a subset of the population. The causation may proceed in both directions simultaneously, suggesting the existence of a self-perpetuating circular flow.

In asserting that there is income inequality, one may be stating a fact (that is, using positive economics, which is free from value judgments) or declaring that a different group occupies a more or less advantageous position. The latter uses normative economics, which involves value judgments. Using social judgments, some of the factors that are likely to impact upon the size of income inequality are resources in relation to needs, opportunity and outcome, and tastes and choices of individuals.

One of the best-known theories of differences and changes in income inequality is Simon Kuznets's In-verted-U hypothesis. Kuznets suggests that as per capita income rises, inequality may initially rise, reaching a peak at some medium level of income, but then declines [Page 532]as the country evolves to a richer, more industrialized status. Cross-section data (that is, data for a number of different countries in the same time period) provide mixed support for this hypothesis. There is even less support for the hypothesis when time-series data (data at different time periods for the same country) are utilized.

In most societies, the existence of income inequality is not necessarily viewed as undesirable, since with equality of opportunity it is not unreasonable to permit inequality in earnings in order to provide sufficient entrepreneurship and effort among individuals. In any case, the existence of income inequality does not necessarily imply the prevalence of consumption inequality, which may be more disconcerting for societies. In that sense, poverty in a country or region may be more closely linked to consumption—rather than income—inequality.

Various measures of income inequality exist. A Rawlsian-type measure would gauge inequality simply in terms of the position of the poorest members of the society. Obversely, one could measure inequality in terms of the stance of the society's richest citizens. Other measures take into account the incomes of both the rich and poor. One popular measure, the 20/20 ratio, is the ratio of the income of the top quintile of the income distribution to that of the bottom quintile.

Another is the Lorenz curve, which after ordering the population by income, plots the cumulative percentage of a country's income received by the poorest x percent of families against x. Complete income equality would of course result if the poorest y percent of families received exactly y percent of the income—resulting in the line of perfect equality. The distribution of income shows greater inequality as the Lorenz curve bows toward the bottom right corner.

A problem in using Lorenz curves to compare income inequality across countries or for a country across time is that the curves may cross. Using the Gini coefficient overcomes this problem since it measures how far a Lorenz curve lies from the line of perfect equality. The coefficient is equal to the area between the line of perfect equality and the Lorenz curve divided by the area under the line of perfect equality. A coefficient of zero suggests full equality and one suggests complete inequality. Gini coefficients are reported in the official publications of some countries, and in the World Bank's annual publications World Development Report and World Development Indicators.

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